Is Debt So Bad?

How you could use leverage to enhance your portfolio

I’ve been watching a lot of Dave Ramsey lately. He’s a no nonsense, common sense personal finance guru who focuses primarily on getting people out of debt. Now there’s a lot of people who don’t believe in his investment advice or his political leanings, but I find his folksy sayings quite entertaining. The stories of his listeners are enlightening.

Some of his callers have gotten into debt from student and car loans; others from foolish spending or bad business ideas; and still more who’ve faced some kind of personal tragedy.

He steers these people steadfastly into paying down their debts by working extra jobs, eating nothing but “rice and beans” and budgeting every dollar with the outcome on the other side of being free. Free from debt, because after all, the “borrower is slave to the lender,” as Dave says.

For the most part, it’s hard to argue with any of this. Of course, you don’t want all these debts hanging over your head. Particularly high interest credit card debt or car loans on depreciating assets. We know all that. You pay too much towards debt, you can’t save, you can’t invest. It sucks.

However, the very rich don’t think about debt in terms of fear. For them it’s just another financial tool in the toolbox. You may have heard of the concept of “buy, borrow, die.” Essentially instead of paying for stuff, they just borrow money (tax free) against their stocks or real estate holdings at a low rate. They don’t pay capital gains and eventually they just die and pass the assets onto their heirs.

More commonly, if you have a low enough interest rate on your mortgage, you might choose to invest money you could otherwise use to pay down the mortgage. If I’m borrowing at 3% and I can grow my money at 6%, it’s presumably worth more to me over time than paying down the loan. Now Dave would disagree with this concept, primarily because of the supposed peace and freedom that comes with paying off the mortgage as soon as possible.

But in this case, I wouldn’t get any peace because paying off a mortgage doesn’t negate the endless costs and massive liabilities associated with owning a home.

I’d rather have the debt than flush all my money into a house.

Borrowing for Investments

Another way you could use debt (or leverage) is to borrow money against your stocks (a margin loan) to purchase more stocks. This comes with a lot of problems because not only could you start losing more money than you have, but the broker could ask for that money back at any time. This sounds like a generally pretty bad idea.

However, I think you could use leveraged ETFs in a way that makes some sense. This doesn’t require actually taking out a loan of any kind, but the leverage is embedded or implicit in the cost of the fund, often at a competitive rate.

Let’s say, for the sake of an example, you want to be invested 100% in US stocks, but you still want to diversify with some other assets like bonds and gold.

You could put half your money in the Ulta S&P 500 ETF (SSO), which gives you 2x exposure to the S&P 500. Then you put 25% in a bond ETF and 25% in a gold ETF. Ultimately you have a portfolio that looks like this:

100% US stocks

25% Bonds

25% Gold

Is it risky to have a 150% portfolio using leverage? Yes, but not necessarily more so than just owning the S&P 500. During the last 10 years that portfolio would’ve done about 1.20% per year better than the S&P with a slightly higher risk adjusted return as well.

Another reason you might do something like this is because you want to be fully invested, but hold on to more cash.

Let’s say you happened to come into a lump sum, say $10,000, and you wanted to put half in stocks and half in bonds. Problem is you’re also worried you might need $5,000 for a new air conditioner because the one you have is 20 years old.

You could put $5,000 into the Return Stacked Global Stocks and Bonds ETF, which gives you 100% exposure to stocks plus 100% exposure to US Treasury bonds. Your remaining $5,000 goes into cash, in case you need it, and you still have the investment portfolio you wanted.

I’m by no means suggesting someone should do this. But is it unreasonable? I don’t think so. There are useful ways to use debt to your advantage in certain circumstances. If I needed money and didn’t want to sell all my stocks and bonds, I’d consider something like this. I use RSSB in one of my accounts so I can add more diversifying strategies.

Big institutions, such as pension funds, have been doing this kind of thing for decades and now it’s fairly easy for the average person, so why not take advantage?

Your House is Leveraged to the Hilt

Now Dave would say the only thing you should be invested in is “good growth stock mutual funds.” However, as much as he’s against debt, he does allow for getting a mortgage to buy a home (paying it off as quickly as possible).

I think most people would consider a mortgage “good debt,” but leverage is leverage. Most people are taking on hundreds of thousands of dollars for this privilege of owning a home.

If you take a margin loan, you could lose more money than your initial investment. If you use leveraged ETFs, you could lose all your initial investment but not more than that. If you default on a mortgage, you could lose your home and all the money you’ve put into it, plus face a series of financial challenges for years. Your credit is destroyed, your wages could be garnished.

Borrowing to buy a home comes with its own set of risks. To Dave’s credit, he pushes doing everything you can to pay it off. But it’s a massive loan that most people don’t have collateral to pay off. And there’s this hamster wheel of work and income that you must maintain to keep paying for it.

You could also use your home to take on even more debt by borrowing against it. I’m getting emails constantly from my mortgage provider urging me to take out a home equity loan. Yay! Another debt payment!

In a recent email they wrote, “float yourself some cash, no sweat … whether it’s a big vacation or a much-needed upgrade, summer can get pricey.”

So the mortgage company wants me to take a loan against my home, which I’m already borrowing money to pay for, so that I can have a fun summer filled with cool trips and a new bathroom.

You think this isn’t a dirty game? My mortgage is like a ticket to getting staked at the casino.

Dave is right. The debt cycle is insidious and he often tells people they simply don’t have the money to buy a home or invest. You can’t invest if you’re broke.

Most people probably shouldn’t have any debt.

But I also think I can use it judiciously to make some slight optimizations in my portfolio.

Or I could buy a swimming pool.

This is NOT financial advice.